On December 20, 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 was enacted as part of the Further Consolidated Appropriations Act of 2020.  The SECURE Act is the most important retirement legislation since the Pension Protection Act of 2006. The intent of the Act is to make retirement plans more easily accessible to employees and less burdensome for employers

The SECURE Act contained many important and positive retirement rule changes, such as increasing the required minimum distribution (RMD) age from 70 1/2 to 72. In addition, it amended the 401(k) and Solo 401(k) plan deadline for adopting a plan.

Setting up Solo 401(k) for 2021

Prior to the SECURE Act, a Solo 401(k) plan had to be adopted in the year in which plan contributions are made.  For example, to make 401(k) plan contributions for 2021, the 401(k) plan must have been established by 12/31/2020

Starting in 2020, as a result of the SECURE Act, a 401(k) plan can now be adopted at any time until the business files its tax return, including extensions. For example, a business can establish a plan on September 12, 2022, for the 2021 plan year.  The Act essentially modified the 401(k) plan adoption rules to coincide with the SEP IRA adoption rules.  This provision received widespread support from the retirement industry since it will make 401(k) plans more enticing to business owners looking for tax deductions.

What is a Solo 401(k) Plan?

A true Solo 401(k) plan is so popular because it is designed explicitly for small, owner-only businesses that want control over their retirement funds.  Any business can setup a Solo 401(k) plan, so long as the business does not have any full-time employees (over 1000 hours) that are non-owners or the spouse of an owner.

There are many features of our Solo 401(k) plan that make it so appealing and popular among self-employed business owners, such as high annual contributions, a $50,000 tax-free loan option, Roth conversion options, and checkbook control.

High Annual Contribution Limits

The most popular reason fr establishing a Solo 401(k) is the high annual maximum contributions, which can be made in pretax or Roth. A plan participant can make annual contributions up to $61,000 annually with an additional $6,500 catch up contribution for those at least age 50. For 2021, the maximum annual contribution limit was $58,000 or $64,500 if age 50 or older.

The annual contribution limit is broken down into two components: (i) employee deferrals, and (ii) employer contributions, also known as profit sharing contributions.

Employee Deferrals

401(k) plan employee deferrals are 100% elective.  In 2022, the maximum employee deferral is $20,500 or $27,000 if over the age of 50.  In 2021, the maximum employee deferral contribution amounts were $19,500 or $26,000 respectively.

Employee deferrals can be made in pretax or Roth and are a dollar-for-dollar contributions, unlike the employer contribution (see below).

Employer Profit Sharing Contributions

Employer profit sharing contributions must be made in pretax money and are tax-deductible.  A business owner that uses a sole proprietor or single member LLC can make employer profit sharing contributions up to 20% of his or her net Schedule C amount up the annual limit, which includes the amount of employee deferrals made for the year (see above).

Whereas, a business owner that has established a partnership, C Corporation or S Corporation, is permitted to make a maximum employer profit sharing contribution of up to 25% of the business owner’s W-2.

As of right now in 2022, 401(k) plans that are established in 2022 for the 2021 taxable year are only eligible to make employer profit sharing contributions for 2021.  Employee deferral contributions for the 2021 taxable year cannot be made if the plan was not established in 2021. 

This rule is expected to change in late 2022 when “SECURE Act 2.0” is passed allowing employee deferrals to be made for a previous taxable year even if the plan is established in the subsequent year.

Solo 401(k) Establishment Deadlines

Any business that operates without an entity type is deemed to be treated as a sole proprietorship. In other words, the business has no entity shielding it from liability and typically operates in the name of the owner.  However, an owner can elect to file to have the business operate in a different name (“DBA”).

A sole proprietor can establish a Solo 401(k) plan for the 2021 taxable year up until the business owner files his or her federal income tax return 1040 (U.S. Individual Income Tax Return).  If you filed an extension, you have until October 15, 2022.  Again, only employer contributions (20% of the net Schedule C amount) would be permitted to be made for the 2021 taxable year.

What about an LLC? A single member LLC is an LLC that is owned by one person.  It reports its business income using Schedule C.  Establishing a Solo 401(k) is the same as a sole proprietorship – you have until you file your tax return.

An LLC with two or more partners, known as a Multi-Member LLC, is taxed as a partnership for federal income tax purposes.  You must file Form 1065 (U.S. Return of Partnership Income) as well as the state-related tax form. If you filed an extension, you only have until September 15 to start your Solo 401(k) and contribute for the previous year. You may contribute up to 25% of your W-2 income for the 2021 taxable year.

A C corporation (or C corp) is a legal structure for a corporation in which the owners, or shareholders, are taxed separately from the entity. A C corporation is required to file Form 1120 (U.S. Corporation Income Tax Return) as well as the state-related tax form. Filing an extension gives you until October 15 to open your Solo 401(k). Like the Multi-Member LLC, you can contribute up to 25% of your W-2 income.

An S corp is a corporation that elect to pass corporate income, losses, deductions, and credits through to their shareholders for federal tax purposes. The S corp follows almost the same rules as a C corp, with one exception. You have until September 15 if you have filed an extension for your taxes.

Conclusion

Thanks to the SECURE Act, business owners with no full-time employees have more leeway for saving with a Solo 401(k). The ability to establish a Solo 401(k) plan the following year gives one more time to accumulate savings to put aside for retirement.

There are two important requirements to keep in mind: (i) the business must not have filed its income tax return for the previous taxable year, and (ii) only employer profit sharing contributions (20% for sole proprietor/single member LLC or 25% for a W-2 corporation) can be made.

Since employer profit sharing contributions must be made in pretax, there is still an opportunity to generate massive income tax deductions if you still haven’t filed your taxes. If you are thinking about setting up a Solo 401(k), keep in mind the deadlines to both open the plan, and contribute to it.